I am a retired Investment Banking professional, most recently Chief Operating Officer for the Bank's Cash Equity Trading Division. I am a passionate free market economist in the Austrian School tradition, a great admirer of the US founding fathers Thomas Jefferson and James Madison and a private investor.

2/08/2011 @ 12:31PM34,101 views

America, poised for a hyperinflationary event?

It is a long standing proposition of many, supported on both theoretical and historical grounds, that one of the surest roads to hyperinflation is one grounded in a government whose answer to every economic and social problem is to borrow and spend the problem away, supported by a central bank able, willing and ready to finance the effort. That support is of course to simply print the money through which to buy the debt so issued by the government – what is euphemistically called monetizing the debt – thereby exploding the supply of money and eventually trashing its value.

So, given the extraordinary borrowing needs of the U.S. government, currently being supported by a Federal Reserve whose QE II asset purchase program is large enough to finance 100% of the government’s funding requirements through at least June, we thought we would take a look at the prospects for a hyperinflationary event in America. And while we think hyperinflation – defined as the total destruction in the value of the U.S. dollar – is a low probability event, a lot, and we do mean a lot more monetary inflation most definitely is not. You see, when you have a government that seems reluctant to change its borrow and spend policies in any meaningful way – a subject we took onhere – teamed up with a central bank chaired by a man who thinks that loose fiscal and monetary policies are the springboard for a downtrodden economy, you have a recipe for a whole heap of monetary inflation. Indeed, in the opinion of THE CONTRARIAN TAKE, never has a U.S. central bank been chaired by a man who is more certain that loose fiscal and monetary policies are exactly what an economy mired in excess productive capacity and high unemployment requires to make things right.

Before we discuss the prospects for hyperinflation, some preliminaries…

Preliminaries

First, U.S. government debt is being here defined as the debt of the U.S. Treasury plus the debt of the government-sponsored agencies Fannie Mae and Freddie Mac (popularly called agencies). Inclusion of the latter may appear to be a bit of a stretch, but as we discussedhere, to us, its inclusion in the U.S. government’s debt footings is obvious. Creations of the U.S. government, these government-sponsored enterprises and their debt obligations have always been implicitly backed in varying forms by the full faith and credit of the U.S. Treasury, a backing made explicitly clear to any and all doubters when on December 24th 2009, in the depths of the credit crisis, the U.S. government gave the government-sponsored enterprises unlimited access to the Treasury essentially until further notice. We wonder why anyone would have thought anything different, that when push came to shove the U.S. government would protect its own, make this implicit guarantee an explicit one and the debt of Fannie Mae and Freddie Mac the defacto debt of the U.S. government.

Second, it is common practice to measure a government’s burden on the economy by comparing the government’s debt to the nation’s productive output or GDP. And while we agree that over the long haul it is a nation’s productive prowess that provides the means necessary to pay the government’s debt obligations, we think it is more instructive to compare those debt obligations to the nation’s savings. You see, it’s a nation’s savings, its willingness to defer consumption that makes the government’s borrow and spend programs possible. All other things equal, an economy that consumes much and saves little is an economy that cannot long afford a borrow and spend government. The crucial question then in any proper examination of a government’s burden on the economy is this… is the nation’s pool of savings large enough to fund the government’s borrowing requirements, for how long and at what rate of interest?

Third, the Federal Reserve is not the only stateside institution that has the power to monetize the U.S. government’s debt. Because of our government protected, fractional reserve banking system, they have a partner – the private banking system – which can and does buy U.S. treasury and agency securities, paying for those securities simply by crediting the bank accounts of the sellers. That’s right, by printing money just like the Federal Reserve.

With those preliminaries dispensed, let’s get to the question at hand…

Is Hyperinflation coming to America?

Let’s start with a long term look at U.S. government borrowing and debt trends through 3Q 2010, the latest available data:

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Your article misses the point about inflation. The problem is that money has to be “borrowed” into circulation. And when this “borrowed” money is repaid or defaulted upon, it goes out of circulation. For a very long time, there has been and over distortion of loans, which has given way to the illusion of prosperity. In fact, there seems to be over $100 trillion dollars of consumer and investment debt compared to less than $1 trillion in actual money circulating in the economy, which means the money supply is shrinking. So, there are simply more people paying off payoffs or defaulting on loans than the creation of new loans. The fed is trying to replace this “black hole of debt” with “printed money” in order to stave off deflation and to keep the banks solvent. After all, if there are no banks to borrow money from, there can be no money in circulation. And the fed is buying Treasuries to keep interest rates down, as opposed to higher rates with less money in circulation, in order to “promote” more borrowing and “recover” the economy. And, the fed “printing money” and “foreign borrowing” is not circulating. Why? Because there are very few people, in mass are taking out new loans for whatever reason. Also, it is common practice for foreign nations to hold accounts at reserve banks. At this level money does not circulate but is “exchanged” for foreign currency. However, the fed printing money does cause a distortion in US exchange rates and causes an increase of reserves for foreign countries whose currency is tied to the US dollar. And as a result, many of these foreign countries are also printing own money in order to “weaken” their own currency, compared to the us dollar, so that they can export goods and services. This is the real reason why foreign markets are growing. It is all a big lie

treetorn69, it is simply incorrect to say that the money supply is shrinking. Michael has written excellent primers and updates on money supply, showing that money supply is in fact growing rapidly — you might want to do some research and get your facts straight before accusing people of “missing the point.

Additionally you don’t even seem to understand the point of this article. Even if money supply WERE decreasing, which it isn’t, your criticism wouldn’t be valid, because the article is talking about the potential for money supply to increase (more) rapidly as a result of monetization should foreigners stop financing our debt.

Michael, excellent article and an even-handed overview of what could potentially cause inflation risk to worsen in the future. (“Even-handed” articles about hyperinflation risk are very rare!)

Although this isn’t the main focus of the article, I do have a question about including GSE debt along with Treasury debt.

Unlike “direct” Treasury debt, GSE debt is asset backed. It is backed by houses, and although those house may be worth less than the debt, there is still a substantial amount of asset backing. So while the Treasury is certainly responsible for that debt, is it appropriate to add gross GSE debt to the total stock of US government debt without accounting for the asset backing?

Why not also include FDIC Insurance. Perhaps even in a “real” manner says as “Total ‘bank money printed” minus 10% (alleged reserve)” you could put it in a column named “Credit Expansion guaranteed by the government” As GSA’s. Would you dare to now include the credit expansion of the TBTF banks ? OMG NO, the OCC (OCC. org) says their derivatives, U.S. alone are more than $235 trillion (worldwide maybe $800 trillion). But not to worry, the TBTF banks claim these insurance policies with zero backing could only lose about 4% max. The Fed would only need to print less than $5 trillion, unless of course there is a “Black Swan Event”. And what did von Mises say,”"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

You raise a good point. You can make the case though that Treasury debt too is “asset backed,” by the assets of the U.S. government. The Treasury lists about $2.9 trillion fiscal year 2010. So its net debt is 11 trillion (gross $14 trillion debt less $3 trillion assets). A net asset view would be a correct one I think if we were looking to liquidate the government or restructure its debt, including sale of some of its assets (military bases or national parks, whatever). But on an ongoing basis, from the standpoint of the government’s borrowing burden – new and rolls – on the economy, and the Fed’s response to it, I think the gross number issued to the public is the correct view.

Regarding treetorn69 comments, he/she makes a good point. Money is extinguished (falls out of circulation) upon default, but only money issued by private banks as an uncovered money substitute; ie when created out of thin air via our fractional reserve banking system. (In contrast, debt that is issued via a true credit transaction ie through savings can default, but it cannot lead to a reduction in the money supply).

I attempted to deal with some of these mechanical issues through a glossary… http://blogs.forbes.com/michaelpollaro/austrian-money-supply-definitions-sources-notes-and-references/

A great intro book fwiw on my thinking can be found here… Rothbard, 1994. “The Case Against the Fed.” Ludwig von Mises Institute, Auburn, Alabama. http://mises.org/books/fed.pdf

For example, in the Weimar Republic, German economists, officials and businessmen alike believed that a fall in the value of the mark (against gold & the dollar) should necessitate more money printing to compensate. Of course, every money printing exercise brought about conditions where the market tried to make the mark work, but that effort by the market would forever be thwarted by the people at the Reich & the Reichsbank.

Likewise, during the French Revolution, the idea was to print assignats whenever a ‘scarcity of circulating medium’ arose. Only every money printing exercise brought about the ‘scarcity of circulating medium’ that it was intended to alleviate.

So both of these have the hyperinflationary property; insofar as the false idea was held, money printing brought on more money printing (immediately).

I compare these two periods to today’s dollar here: http://greshams-law.com/2011/03/07/the-idea-that-killed-the-german-mark-prospects-for-the-dollar/ http://greshams-law.com/2011/03/09/the-idea-that-killed-the-french-assignat-prospects-for-the-dollar/

So, I say to you, we shouldn’t fear the mechanism that foreign creditors dump US debt; rather we should fear the policy reactions to such dumping of US Debt. If social mood sours enough to lodge a hyperinflationary premise into the minds of the masses; then we should be fearful of hyperinflation.

Thanks very much for continuing to post the Austrian Money Supply charts by the way; they’re great!

I agree, hyperinflations are brought on by the ignorance of those who control the printing press – the central bankers. But hyperinflations are also brought on by those who are not so ignorant, but play along with the central bankers for as long as they can profit from inflation; ie, all those special interests who are first to receive all the central bank’s newly printed money. Indeed those are the people that have taken great pains to position themselves in powerful, government-protected positions for that very purpose, with always one foot out the door. We have both of these groups in spades today – the Fed and its misguided apologists on the one hand and its profiteering cheerleaders on the other.

All hyperinflations need a trigger, to set the process in action. Imho, a foreign exit is a very big, very possible trigger for the reasons cited. And at the first signs of a foreign exit from the USD, the Fed’s policy actions, misguided and ignorant as they are, will be to print and print supported in spades by those who get it – the profiteers – and of course those who don’t – the apologists – until domestic bubble explosions and rampant domestic price inflation become a national issue. By that time the profiteers will already be out the door. Only the ignorant will remain to clean up the mess. Will the Fed then in the face of all this go as far as hyperinflation. As I have suggested, I doubt it. But once people start running from the USD in masse anything can happen.

In that context, it seems very very odd that the US would consider harming the interest of its creditor (China) which is notoriously present with abundant workforce in Syria, Egypt, Lybia and which also imports oil from Iran. It sounds very silly to indeed to consider the possibility of war which would harm your creditor.